Newsletter – February 2019

Without wishing to be drawn into the political arguments around Labor’s policy to significantly restrict the ability for investors to claim a tax deduction for negative geared property, I do believe it would reduce house prices. For those trying to get into the housing market this is likely good news, for existing property owners it is less welcome.

Christopher Joye, a contributor to The Australian Financial Review, says:

“Labor’s proposal to heavily tax the nation’s most valuable asset-class—residential real estate—at a time when house prices are suffering their biggest-ever fall is either exceedingly brave or stunningly stupid.

The problem is that the housing correction is accelerating as property investors come to grips with the reality that Labor’s policies will, as Deloitte Access’s Chris Richardson explained on ABC Radio, reduce the value of all homes by several percentage points.

While some erroneous reporting alleges Labor is protecting existing property investors from its proposals to increase capital gains tax by 50 per cent and eliminate negative gearing, which is equivalent to a 23 per cent hike in interest repayments, the truth is that these measures will adversely affect the price of all properties.

A rental property is only worth what someone is prepared to pay for it. Although existing owners might be able to continue to negatively gear and pay the same CGT, all future buyers of these assets will not.

That means that current investors who think they are being quarantined from Labor’s housing taxes will, in fact, be hurt on their resale values because Labor’s policies will apply to the buyers who can’t negatively gear and who will pay 50 per cent higher CGT”.

Note, there is no certainty that the changes Labor has foreshadowed will occur as they first must be elected and then get legislation passed through the parliament. Even if this does happen it is unlikely to apply to properties purchased before July 2020 as some lead in time and grandfathering of existing arrangements is probable.

Australian Interest Rates look likely to fall this year

In bad news for those with term deposits and cash savings, it is looking increasingly likely that the Reserve Bank will be forced to cut official Australian interest rates this year and that will lead to lower deposit rates. For borrowers, this should see some reduction in borrowing rates, though perhaps not by as much as official interest rates as increasing funding costs could see major lenders not fully passing through official rate cuts to borrowers.

The downturn in the housing market is impacting consumer sentiment as can already be seen in things like falling sales of luxury cars. As people feel less wealthy they are inclined to save more and spend less, thus leading to a weakening economy. This increases the likelihood that the RBA will respond by cutting interest rates in an attempt to stimulate consumer spending and the economy.

The Reserve Bank governor has indicated that he currently sees no need to change interest rates but, just as the US Federal Reserve quickly changed it’s interest rate outlook last month, I expect the RBA will also respond by mid-year if the housing downturn continues.

Low interest rates are the norm around the world and central banks don’t feel they can move rates up without risking an economic slowdown, or worse. Unfortunately Australia is now another country where the levels of household indebtedness and the sluggish economy preclude any upward move in interest rates back to what were more “normal” levels.

I think it is too soon to call an imminent Australian recession, though some are now forecasting that. After nearly 28 years without a recession the possibility of a recession starting late this year or next year is increasing. If it happens expect interest rates to reach historic lows.

Timing your Investments

Everyone knows that it is wise to “buy low and sell high”, though it is much easier said than done. Anton Tagliaferro, a very successful and experienced fund manager at Investors Mutual, has some sage advice on trying to time investments.

“Corrections are a natural part of all sharemarket cycles. The best protection for long-term investors in all price downturns is to be invested in a diverse range of high quality, income producing assets; to stay calm and to see if opportunities emerge where one can add good quality assets at depressed prices to one’s portfolio.

Whenever sell-offs in the market occur it is always worth remembering the words of renowned value investor Seth Klarman:

“While it is always tempting to try to time the market and wait for a bottom to be reached (as if it would be obvious when it arrived), such as strategy has proven over the years to be deeply flawed. Historically little volume transacts at the bottom or on the way back up and competition from other buyers will be much greater when the markets settle down and the economy begins to recover. Moreover, the price recovery from the bottom can be very swift. An investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better.”

We are certainly not in a bear market for shares currently, having largely reversed the significant falls that occurred late last year, but it is helpful to keep this advice in mind should we see significant price volatility this year, as I expect. With residential property, the signs are that the downturn has further to run but remember no-one knows when the bottom will be reached.

This newsletter contains general advice. It does not take into account your individual objectives, financial situation or needs. You should consider talking to a financial adviser before making a financial decision.